The 401(K) Doesn’t Need to Be Overhauled

The New York Times recently ran a story titled “Should the 401(k) be Reformed or Replaced?” the author, Steven Greenhouse, seem to cover a litany of topics ranging from the 401(k) history to a new government mandated retirement account without actually discussing personal responsibility.  The 401(k) doesn’t need to be reformed, replaced or overhauled people just need to get responsible about their own retirement.

People Need to Save More Money for Retirement

The typical worker age 55 to 64 had just $54,000 in a 401(k) in 2010, according to a new report by the Center for Retirement Research at Boston College, and households with workers in that age group had $120,000 in retirement savings on average, if the money rolled into I.R.A.’s was included. That $120,000 is less than one-fourth the savings recommended by many retirement experts. Moreover, the center calculated, that $120,000 would provide an annuity of a paltry $7,000 a year

Without additional information, the amount in one’s 401(k) is essentially a worthless abstract number.  For example, if the people surveyed only made $35,000/yr why would there be any reason to assume that they amassed a ridiculous 401(k) or IRA?  Maybe the people interviewed had a government backed pension which would obviously lessen the need to save.  Ignoring growth if a person had $50,000 in their qualified account and they are 50 that means that over their working life from 22 to 50 they saved $1,785/yr or $148/mo. Why would anyone think that would lead to a successful retirement?

Further $120,000 is a very different number if you live in the middle of the Country versus living on the coasts.

People Need to Understand Risk as a Concept and in terms of Investing

As is customary, Mr. Greenhouse uses a random couple that no one knows to provide a sense of feeling.  This couple:

JOHN GREENE worked for 30 years at an Oscar Mayer plant in Madison, Wis., deboning hams and loading boxes of hot dogs. His 401(k) plan grew to $60,000, and soon after retiring he began withdrawing $3,600 a year from it, money that allowed him and his wife to take what he called a wondrous two-week trip to Scotland, his ancestral homeland.

LOSS The Greenes lost about 70 percent of their 401(k) savings in the market downturn. Some experts wonder if the 401(k) rules need to be revised.

But when the financial markets plunged four years ago, his 401(k) dropped to less than $18,000.

“We lost more than 70 percent,” he complained, even though a highly recommended investment firm was managing his 401(k). “They’re very risky.”

For Mr. Greene, 77, the money he withdrew each year provided him and his wife some breathing room — and comforts — on top of the $29,000 they receive annually in Social Security and pension payments. But though it has rebounded a little, his nest egg has declined so much that he withdraws far less than he used to. The result: “We can’t do trips like Scotland anymore,” he said.

They were retired so it is likely Mr. Greene was probably referring to his IRA and what happened in that not his 401(k) which makes it odd why their example was even used.  If he did leave the money in his 401(k) he was probably paying ridiculous investment fees.  Even if we were to assume we were talking about his 401(k) and not his IRA, to lose 70% of his assets he was likely to be invested way to risky for someone who was 73 at the time of the crash (the article mentions he is 77 and the 70% loss was 4 years ago).  I know it is customary to trust almost blindly your professional whether it is your doctor, lawyer, or investment advisor but people should have a pretty good grasp of how much risk they could tolerate in their nest egg.  If this was completely ignored then they should bring a suit against their “highly recommended investment firm.”

According to a report by the Congressional Research Service, 38 percent of 401(k) participants age 55 to 64 have 80 percent or more of their 401(k) assets in stocks — even though many experts say it is unwise to invest heavily in stocks so close to retirement age because a large chunk of one’s savings could quickly evaporate in a market downturn.

Running a quick SPIA quote (assuming both of the Greene’s are 77) it seems that $60,000 would buy a joint survivor single premium immediate annuity would provide $392/mo and some of that is not even taxable (it is referred to as exclusion amount).  Let us rewind the clock and run the same quote if they were 73 – $342/month or $4,104…MORE THAN WHAT THEY WERE PULLING OUT.

Obviously hindsight is 20:20 but are you near that age? Maybe it is about time you take some risk off the table.

Not Everyone’s Retirement Will be the Same

If everyone’s working life is different why would everyone assume that retirement would be the same for everyone?  There is a portion of the article dedicated to a proposed government system where people basically buy guaranteed returns from the government.  This is fantastic since I was just thinking about how much extra money the government has lying around to take on even more risk! Jesus.

It isn’t that I can’t empathize with the Greene Family but I think that I have read too many of these stories to understand how people could be so blind to their own finances.

6 Responses to The 401(K) Doesn’t Need to Be Overhauled

  1. They were pulling out way too much at 7%. At that rate, the saving wouldn’t last long. They should cut back to 4% and just save up for the trip. I don’t know. Or maybe just enjoy life now. It’s going to be difficult to travel as you age anyway.

  2. I have to agree with your assessment on his risk. I hate to say it but if that is all he had in his account he certainly wasn’t prepared to take yearly trips to Scotland either.

  3. I love how media always picks the right odd ball sensational story to make their point. If they lost 70% they must have cashed out at the bottom because the market has come back quiet strong. If my portfolio dropped 70% in investment losses I wouldn’t be withdrawing money from it if I didn’t need to and Ireland trips aren’t a need.

  4. Overhauled? Hm. They do have some drawbacks, not the least of which is limited investment choices and high costs.

    And there’s the issue that some people are very naive about investing and should not be messing around in the stock market. These folks are far, far better of in a traditional pension plan where, with any luck at all, funds are professionally managed.

    One of my students, a fifty-ish guy working as an LPN and back in school to upgrade skills in quest of a raise, did exactly what Lance describes: panicked when the market crashed and sold everything in his retirement fund. He was left with no savings to speak of and a powerful conviction that investing in the stock market is about as smart as betting at the craps table.

  5. I think the 401K system is fine, per se. The problem is that people are using it as an investment vehicle and not as long term guaranteed savings. If the 401K is used as guaranteed savings its fine. As an investment vehicle it breaks down with many individuals because they don’t monitor closely the investment options. The individual only notices when there is a gigantic drop in the market. That individual took too much risk in the first place , often based on investment adviser encouragement. An individual Roth IRA can be better because the individual actually has to do something to open it and at least has the potential to attend it a little better. Fooling around in the market with your retirement money is just that…fooling around.

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